Microsoft Buys Skype

“All these bitches and niggas still hatin’
I used to be ballin’, but now I’m Bill Gate-in'”
–Lil’ Wayne

Shortly after we started Andreessen Horowitz, we, along with our partners at Silver Lake Partners and Canada Pension Plan Investment Board, bought Skype from eBay for slightly more than $2B. The investment generated a tremendous amount of controversy for us. Marc and I were known as angel investors, so investing $50M of our $300M fund in one deal surprised people. While consistent with our stage-agnostic strategy, it was a very big deal very early on in the fund. To make matters more exciting, other investors and writers broadly criticized the deal. Joe Nocera of the New York Times wrote:

“Many people on Wall Street–and a number of telecommunications experts I spoke to this week–were stunned by the price Skype sold for, and not just because we’re in the middle of a recession.”

That controversy ended this morning when Microsoft announced that it was buying Skype for $8.5B less than two years after we bought it from eBay.

Let’s look back at the original decision and see why it turned out well. At the time, people criticized us for two primary reasons:

1. Ebay might not have owned Skype’s underlying intellectual property. Skype’s founders, Niklas Zennstrom and Janus Friis, held an IP claim against Skype. Many speculated that the founders would use their claim to shut down Skype and leave investors with nothing. This made the company theoretically impossible to buy.

As Nocera wrote:

“And so, the mystery of the Skype deal: why were the winning bidders willing to pay so high a price for a company whose very existence could be threatened by this lawsuit? One possibility is that they have nerves of steel. The other is that they know something nobody else does.”

2. The shifting technology landscape would tilt the playing field away from Skype. While Skype won the original Internet telephony wars, they did so with a fat desktop client. From a technology standpoint, at the time, it was technically impossible to field a high-quality web client or mobile product, but that time wouldn’t last. Many observers believed–as the world inevitably transitioned to mobile and web–Skype would be left in the dust.

With a company as complex as Skype, investors draw different conclusions about the same facts. In this case we had the same data as everybody else, but we had a radically higher opinion of Skype’s founders and employees than the investors who passed on the deal. We believed that we could work with rather than against the founders. More importantly, we believed that Skype’s engineering team, led by the original Eastern European wizards who created the service, could compete and win against anybody.

We thought that Niklas Zennstrom and Janus Friis wanted Skype to be a huge success and would do everything in their power to make that happen. As a result, we did not think the doomsday scenario that greatly concerned other investors–that the founders would attempt to shut down the company through the courts–was an actual possibility. Based on the founder’s motivations, we felt that we’d quickly settle the IP litigation. Both sides wanted to get on with the business of making Skype more competitive and could not afford to waste time bickering about IP ownership.

We couldn’t have been more right about that. After quickly settling the litigation, both founders immediately made major contributions to the business through their energy, insight, and intellectual prowess. And boy did we need them to do that, because we soon faced full frontal assaults from both Google and Apple.

When giants attack

In a direct attack, Google offered a free competitor to Skype’s U.S. paid product and a heavily discounted competitor to Skype’s international product. Google then aggressively promoted these cheap products to their enormous Gmail user base by forcing every Gmail user to view Google’s Internet telephony advertisement before allowing them to access their email. What was the result of this effort? Skype new users and usage growth has accelerated since Google’s launch culminating in:

On the mobile front, Apple built video calling right into the iPhone, making their product the default offering for iPhone users. How did that impact Skype’s usage on the iPhone? 50 million users have downloaded Skype’s iPhone product since the release of Apple’s Facetime.

In retrospect, it was easy for people to underestimate the quality of the Skype engineering team and the power of Skype’s network effect. When we bought the company from eBay, many thought that Skype, like so many acquired technology companies, had lost its technical talent. Through our research we found that Skype had a core group of engineers who were completely dedicated to the mission. They stayed through the eBay acquisition and were determined to make Skype the communications company of the future. Over the past decade, this team consistently introduced groundbreaking technologies ranging from highly resilient and scalable peer-to-peer networking to radically higher sound quality through dramatically superior codecs. In doing so, Skype out-innovated the competition in the most important areas. When combined with its powerful network effect–how valuable is a video calling service if there is nobody to call?–Skype became a formidable competitor.

Smart move, Microsoft

Today, I tip my hat to an old rival, Microsoft. By acquiring Skype, Microsoft becomes a much stronger player in mobile and the clear market leader in Internet voice and video communications. More importantly, Microsoft gets a team, led by the exceptional Tony Bates, that can compete with anyone.

Ben Horowitz is co-founder and general partner of Andreessen Horowitz. He co-founded Loudcloud, later renamed Opsware Inc., in 1999 and served as CEO of the company before it was acquired in 2007 by Hewlett-Packard. He was most recently vice president and general manager of Hewlett-Packard’s Business Technology Organization Unit.

About Voices

Along with original content and posts from across the Dow Jones network, this section of AllThingsD includes Must-Reads From Other Websites — pieces we’ve read, discussions we’ve followed, stuff we like. Six posts from external sites are included here each weekday, but we only run the headlines. We link to the original sites for the rest. These posts are explicitly labeled, so it’s clear that the content comes from other websites, and for clarity’s sake, all outside posts run against a pink background.

We also solicit original full-length posts and accept some unsolicited submissions.

AllThingsD by Writer

AllThingsD.com is a Web site devoted to news, analysis and opinion on technology, the Internet and media. But it is different from other sites in this space. It is a fusion of different media styles, different topics, different formats and different sources. Read more »